KC Fed chief discusses farm credit stress, interest rate changes

When Esther George introduces herself, she almost always discusses her life growing up on a farm in northwest Missouri.

“I’m a sixth-generation farmer in northwest Missouri, so when I hear about trade, I think about the price of my soybeans and my corn,” said George, the president of the Federal Reserve Bank of Kansas City, Missouri.

George spoke on her outlook for the United States economy in general and the farm economy in specifics during an address to the KC Fed’s recent annual agricultural symposium.

George discussed the relative health of the farm economy compared with the farm crisis of the early 1980s.

“Many things are relative,” George said. “If you look at history, back to the 1980s, it’s not so bad.

“On the other hand, the farm sector has experienced a lot of consolidation. Today’s farms are much bigger than they were before and banks, I think, are still mindful of their underwriting standards.”

That said, George added she didn’t want to underestimate the stress that exists today or could come.

“We are in a rising rate environment. It does not help when you have marginal borrowers or borrowers who are struggling, perhaps young farmers who’ve incurred a lot of debt in the purchase of land and equipment,” George said. “There are pockets of stress as we look around. I don’t think it’s anything to the point of alarming at this stage, but the question is how much longer we will experience this continuation of low commodity prices and low farm income.”

One thing of note throughout the current stress situation, George said, has been how land values, for the most part, have held up in the face of falling incomes.

“That is something to look at. I suspect that is providing some support to borrowers today,” George said. “It is giving some assurance to some of the lenders as they look at operating lines. Eventually, that catches up with you, as cash flow matters.

“We see stress in ag banks, but no where near the concerns we had in the 1980s. We need to keep an eye on it. The banks are keeping a close eye on it as well.”

On the broader economy

George, a member of the interest rate setting Federal Open Market Committee, also examined the economy as a whole. With the economy at or beyond most estimates of full employment and inflation near the FOMC’s 2 percent objective, monetary policy should be a neutral influence on the economy,” George said.

“However, in my view, policy is still providing accommodation. Gradual further increases in our policy rate will be necessary to return policy to a neutral stance, although there is considerable uncertainty about exactly how far or fast we need to go,” George said.

“Thus, policy must thread the needle between moving too slowly toward neutral, which could lead to an undesirable increase in inflation, and moving too aggressively, which could precipitate an economic downturn.”

George called the U.S. economy in “excellent shape”, operating with tight labor markets and low and stable inflation.

“The unemployment rate at 4 percent is well below most estimates of full employment. In addition, headline inflation as measured by the Fed’s preferred indicator, the personal consumption expenditure price index, recently reached 2.3 percent, while the core measure excluding food and energy came in at 2 percent—consistent with the Fed’s inflation objective,” George said.

Looking back at the first half of the year, real gross domestic product—the broadest measure of economic activity—increased at a solid pace, accelerating from a moderate 2 percent annual rate in the first quarter to an expected growth rate of around 4 percent in the second quarter, based on various GDP tracking models, George said.

“Looking ahead, we expect continued economic growth at or above estimates of the economy’s longer-run potential growth rate of around 1.75 percent. Economic growth is broad based, and the economy appears to be firing on all cylinders,” George said.

“Consumer spending has supported overall economic growth since the beginning of the expansion, but more recently, we have seen a pickup in business spending on plant and equipment. In addition, we are beginning to see an increase in the pace of wage gains.”

The employment cost index—a broad measure of labor compensation that accounts for employment shifts among occupations and industries—accelerated over the past couple of years to a 2.7 percent annual growth rate in the first quarter, after having hovered for several years around 2 percent. These wage gains along with ongoing increases in employment will continue to support increases in personal income and spending over the remainder of the year and on into next year.

“With this strong performance and a legacy of low interest rates, financial stress may be building in some sectors,” George said. “The corporate bond market and subprime borrowers appear to be at some risk should interest rates rise sharply. In addition, asset prices remain elevated.

“Nevertheless, regulators have judged the financial system to be stable, with manageable vulnerabilities. They point, for example, to the most recent assessment from the annual stress testing of the largest banks. That said, I am concerned that regulators are not doing more to build resilient capital buffers into the banking system at a time of cyclical strength.”

Risks to the economy

The predominant downside risks come from uncertainty around trade policy, George said.

“To date, the impact of new tariffs on the broad economy has been minimal, and I have not incorporated any significant effect into my baseline outlook for the broader U.S. economy. However, anecdotal reports from our business contacts suggest that some companies are taking a ‘wait and see’ approach to new capital spending due to uncertainty about future trade policies,” George said.

“Whether this will materially slow the economy over the next couple of years or threaten the sustainability of the expansion is something that I will be monitoring carefully.”

Policy actions, however, will be data driven, and given policy lag, actions need to be forward thinking, George said.

“Data dependence means that policymakers should adjust their forecasts and associated policy paths as necessary based on the flow of incoming data. Therefore, I will be monitoring signs that might indicate whether we are nearing neutral or have further to go,” George said. “For example, further downward movements in the unemployment rate or upward momentum in inflation would suggest to me that we have more work to do. On the other hand, stabilization of inflation and unemployment around their current levels might suggest less urgency for further policy action.”

All the same, George said, the U.S. economy is currently in very good shape, unemployment is well below most estimates of its longer-run level, and inflation has moved up to the FOMC’s objective.

“My baseline outlook is for the expansion to continue at a moderate pace, while recognizing there are significant upside and downside risks. With a long-run view to sustain the expansion, monetary policy will need to move from an accommodative stance to a more neutral stance,” George said. “Threading this needle will be challenging in the face of numerous uncertainties and the ongoing complexity of unwinding the extraordinary policy actions taken in the aftermath of the global financial crisis.”

Larry Dreiling can be reached at 785-628-1117 or [email protected].